The new, new bubble

Commentary: Convertible bonds recall Net's bad habits

BambiFrancisco

SAN FRANCISCO (CBS.MW) -- This month, Herman Miller released a new ergonomic chair called the Mirra.

Strikingly reminiscent of the company's Aeron -- the high-priced office chair that became an icon of the dot-com period -- the Mirra's arrival is one more sign that we have entered a neo-bubble era.

Remnants of bubble paraphernalia and behavior have re-emerged of late, though often cloaked in new garb.

I'm referring to such boom-years-reminiscent conduct as visits from private dot-com companies eager to share their PowerPoint presentations; partner conferences at lavish resorts; and one-day gains based on press releases, like the 18 percent jump in Virage
VRGE
on Monday after the company announced a Department of Defense deal.

Concurrently comes the temptation to fall into old habits, like doing "whatever it takes" to make a deal.

Look no further than the bubble developing in the convertible bond market, where banks are offering aggressive terms (like zero percent rates and dilution only at high conversion rates years down the road) in record numbers to land clients.

One cannot help but wonder whether the desire for a piece of these capital-raising deals motivates only those who spend their days on the investment-banking side of the Chinese Wall.

If money is at stake, and it is, why wouldn't investment banks use every bullet in their arsenal to win a deal?

We're fresh on the heels of Wall Street's $1.4 billion settlement to reform the conflicts of interest between investment bankers and analysts, but it appears that it's business as usual.

Picture perfect

Getty Images
GYI
a company that distributes images online and offline, just completed a convertible bond on June 3 at a 60 percent premium. Deutsche Bank and Goldman Sachs led the deal.

Deutsche Bank issued a glowing report on Getty Images on May 27, just a week before the convertible sale. Analyst Jeetil Patel initiated coverage of Getty with a "buy" rating and a 12-month price target of $46, which was 24 percent above where the stock was trading when he issued the report.

According to Deutsche Bank, researchers and bankers are kept separate, and Patel did not know about the upcoming bond sale.

Granted, many companies are issuing convertibles these days to improve their cost of capital and take advantage of the bankers giving away the shirts off their backs.

Nearly $4.5 billion in convertible bonds were issued last week, the third straight weekly record. The total included Getty's $265 million offering and a $500 convert by Omnicom
OMC, +0.45%
For all of May, $14.4 billion was raised through 48 convertible-bond issues, the highest number since $15.2 billion was raised in February 2002, according to Dealogic.

Patel, who follows Yahoo
YHOO
Amazon.com
AMZN, -1.38%
EBay
EBAY, -0.44%
and other Internet names, may just be sharing his optimism for Internet stocks. He initiated coverage on Ask Jeeves
ASKJ
with a "buy" rating a day before Jeeves sold its convertible bond offering. Deutsche Bank was not the banker on that deal.

Getty has a long-standing relationship with Deutsche Bank. The last time Getty issued a convertible in 1998, Deutsche Bank was its banker, according to Dealogic. When Getty raised money during a secondary offering, Deutsche Bank was also a banker along with Morgan Stanley. In fact, Alex Brown -- which was bought by Bankers Trust in 1997, which was then swallowed by Deutsche Bank for $9.1 billion in 1998 -- brought Getty Images public.

But the timing of the call and the deal raised a few eyebrows, particularly because the report didn't exactly reflect new shifts in Getty's business.

"Is there a taint of impropriety in the middle of a witch hunt?" asked Bruce Lupatkin, former head of research at H&Q and now a fund manager at North Bay Technology Partners. "A reasonable person would think so."

Jeetil's epiphany

Patel predicts that sales for Getty will grow 11 percent this year to $514 million and 4 percent in 2004 to $563 million. He estimates that earnings should grow 32 percent to $1.15 per share in 2004 from 87 cents in 2003.

His support for the company is not much different from other Internet analysts who have said that Getty has a similar business model to that of EBay. Getty has relatively fixed costs and does not have inventory risk. Patel says Getty Images is "quite similar to Monster Worldwide," in that it has a hybrid Internet and offline strategy.

Monster is trading at 46 times 2003 earnings of 38 cents and 29 times 2004 earnings of 60 cents. Using that as a model, Getty should trade at 40 times 2004 earnings, and 25 times free cash flow, wrote Patel. That multiple supports Patel's price target of $46.

While some other analysts have had positive comments about the company, the average rating for Getty is a lukewarm buy, according to Thomson/First Call. This is down from its peak rating on Jan. 10, as a result of several ratings downgrades this year.

In late April, Argus Research issued a report on Getty with a "hold." Argus has far more conservative expectations for earnings growth. The independent research firm expects Getty to grow earnings next year by half the growth rate estimated by Deutsch Bank.

Deutsche Bank stands behind its analyst.

"We have strict firewalls between our research and capital market businesses, which were followed, and research was unaware of any pending deals and banking was unaware of any research activity," said Ted Meyer, spokesman for Deutsch Bank. "The policies are in place and they worked exactly as intended."

We can also assume that Patel is not receiving any compensation. In the spirit of full disclosure, his report says: The lead analyst, "has not and will not receive any compensation for providing a specific recommendation or view in this report."

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